Why You Should Avoid This Coal Miner

Central Appalachian (CAPP) coal has a high energy content, but it's expensive. That's led to a switch away from the region and an increase in demand for Powder River (PRB) and Illinois Basin coal (ILB). That's bad news for one miner, but good news for a couple of others.

ScrubbersThere was a time when utilities used the highest energy content and lowest sulfur coal readily available to them because it made the most economic sense. However, in an effort to comply with increasingly stringent regulations, electric companies have installed devices called scrubbers. Scrubbers reduce harmful emissions and allow for the use of less expensive, and less "clean," coal.

This isn't a new development, but it is one that appears to be gaining steam. In fact, the Kentucky Energy and Environment Cabinet recently highlighted that CAPP basin Kentucky coal production is at a 65 year low. And the trend is only going to get worse. For example, Southern Company (NYSE: SO) plans to cut Central App coal to just 1% of its coal supply over the next three years.

A tough road aheadThat's going to be bad for Alpha Natural Resources (NYSE: ANR) . About 45% of the miner's revenues are generated from its eastern thermal operations. Only around 10% comes from its western, PRB business. The rest is metallurgical coal.

Alpha Natural Resources recently highlighted the depth of its problem. At mid-year, stockpiles of PRB and ILB coal at utilities were around 65 days or so, Central App coal stockpiles were twice that at over 130 days. Clearly, there's a big shift going on and Alpha Natural Resources isn't as well positioned as competitors for the change.

Technology to blameTechnology is partly to blame. And technology also looks set to make things worse. Southern Company is building a new coal plant that will be the first in the country to use carbon capture technology. In addition, Southern's Kemper plant uses coal gasification, which makes burning coal a cleaner process. The plant's fuel will be lignite, the lowest cost and quality coal.

In other words, Southern Company is building the cleanest coal electric plant in the country. and it is going to burn the dirtiest coal. That's a major statement and one that should frighten investors in Alpha Natural Resources, which has a heavy concentration in the cleanest and most expensive coal.

A better positionThe trend away from CAPP coal, however, has been a benefit to two other miners—Cloud Peak Energy (NYSE: CLD) and Alliance Resource Partners (NASDAQ: ARLP) . Cloud Peak's business is exclusively in the PRB region, the lowest-cost coal basin in the country.

Moreover, Cloud Peak recently inked a deal with the Crow Indians that could more than double its PRB reserves. So it has secured years of production in a region that should see increased domestic demand as utilities switch their coal basin allegiances.

Alliance Resources Partners, meanwhile, has already been a huge beneficiary of the switch. The company has been posting record annual results for more than a decade. In fact, while Alpha has cut production, Alliance has continued to increase its output through the coal industry's downturn. Alliance operates largely out of the ILB region.

Clearly, Cloud Peak and Alliance Resource Partners are in the right places at the right time. While Alpha has lost money for seven consecutive quarters, Cloud Peak and Alliance have both been in the black throughout -- an impressive feat when the broader industry is struggling.

Although Alpha is a good company, if you are looking for a coal play, it's probably best to avoid it for now. Both Cloud Peak and Alliance Resource Partners are better positioned to take advantage of the utility industry shift toward lower quality coal. And if Southern Company's Kemper facility proves to be a technological watershed, the pace of CAPP coal's decline could steepen.

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